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What's stopping Russia’s reforms?

Dmitri Travin
27 July 2008

When Soviet power ended, it went through a period of precipitant change. But more recently, reform has ground to a halt. Why has this happened?

Economic reform has been through several stages. The main aim in the early 1990's was liberalisation of the economy. State enterprises were privatised, the principle of private property was established and market competition was introduced. This phase was more or less successful. But having got so far, the reformers failed to ensure financial stability.

In the mid-1990's the main macroeconomic task was fighting inflation, for as long as prices kept rising so fast, the economy could not grow. At this stage, the last thing on most people's minds was further reform, or moving to the next stage of market transformation. Their only concern was that the post-Soviet economy should survive, and that the changes carried out by President Boris Yeltsin and the leading economic reformer, Yegor Gaidar should be consolidated.

Only with the start of the new century did Russia finally enter a period of relative financial stability. The economy began to grow and the capital that had fled abroad began to return. At this point, people started talking about a second stage of reform. The time was ripe, as widespread popular support for Vladimir Putin had ensured political as well as financial stability.

But in fact, the only genuinely successful reform to come out of this period was Finance Minister Alexei Kudrin's tax reform. The main tax rates were reduced and the progressive personal income tax was replaced by a flat tax. This greatly simplified the whole tax system and helped bring into the open wages which had previously been paid in cash, under the table.

A whole number of other important reforms were announced at this point. Some never even got off the ground, while others were so emptied of their substance that they had practically no impact on economic development. Opinions vary on why the second stage of Russian economic reform met such a sorry fate, but there seem to be two root causes.

Firstly, Putin realised that thanks to the growth of GDP and the inflow of petrodollars, the country could get by perrfectly well for a while without any reform at all. Second, the Kremlin leadership favoured the kind of macroeconomic populism familiar from the experience of Latin American countries. This has been studied, in particular, by scholars in the U.S. such as Rudiger Dornbusch and Sebastian Edwards.

The absence of new reforms has not yet had a negative impact on Russia's considerable GDP growth or on continued popular support for Vladimir Putin and the current president, Dmitry Medvedev. But unfortunately, the brake on reform is not without its consequences. Several crisis areas can be identified today in which serious problems are building up. Some of them are already making themselves felt, while others will cause headaches for the authorities only in the medium and long-term.

Nomenklatura privatisation

The first crisis area is the possibility of widespread nomenklatura privatisation, sometimes called spontaneous privatisation. This concept emerged in the Soviet Union at the end of the 1980s, when enterprises gained greater independence but were still in the hands of the state. They were being run by managers interested in diverting as much of their assets and property into their own pockets as they could. The mass privatisations carried out in 1992-1994 reduced the opportunities for these kinds of abuses, but the practice did not disappear altogether.

The biggest opportunities for nomenklatura privatisation today exist in the unreformed social sector.

Reform of higher education

Russian higher education is one of the clearest examples. The heads of higher education establishments (the rectors, deans and others in charge of student intake) often ‘privatised' their universities. Formally speaking these are in state hands, but private individuals are the ones making commercial profits out of Russia's supposedly free higher state education.

It is well known that getting accepted to a prestigious course of study requires a bribe. The heads of many higher education establishments make much of the need to maintain free higher education, in order to give all prospective students equal opportunities regardless of whether or not they have money. But the reality is that they have to pay in any case. They do not pay the state, but the person in charge of admissions. In some cases this is a bribe in every sense of the word. In others, money is formally paid to teachers for the extra lessons they give prospective students. Elsewhere, the ‘exchange of services' common in Soviet times is practised, when a rector admits the son of an influential figure say, who in turn helps the rector sort out some important matter or other.

There are two means of dealing with this problem. One is to develop fee-paying education. The other is to introduce a nation-wide set of final school exams. Developing fee-paying education alongside the supposedly free state higher education system would not end the opportunities for bribe-taking, so the state and the people running the universities have no objection. But the introduction of nation-wide school exams has met with fierce resistance from rectors. It means that students are admitted to universities on the basis of the results of an exam conducted by the state outside the university, depriving them of the possibility of using their positions for personal enrichment.

To be fair to the rectors, nation-wide exams do not adequately assess students' creative abilities, so there is some justification for the rectors' criticism.

Healthcare reform

The unreformed healthcare system offers another example of how people use their position for personal enrichment. Russian hospitals are in a terrible state today. The free healthcare system is catastrophically underfunded. Doctors and other medical personnel earn little, there are not enough beds in hospital wards and patients receive a very meagre food ration.

The purely formal introduction of a medical insurance system in the 1990's has done nothing to change the situation. Patients still find themselves forced to pay extra out of their own pockets for supposedly free services.

True, the mechanism for paying for these ‘free' services is different to that in the universities. As well as paying the heads of medical establishments, patients pay the doctors who perform their operation, the nurses carrying out various procedures, the hospital aides who change the beds. You have to pay for a comfortable bed in the ward rather than in the hospital corridor, or to get donated blood, which is always in short supply, and so on.

In many cases there payments are a voluntary reward patients give to medical personnel. But this does not change the essence of the problem: this system keeps the medical services market closed and uncompetitive, and therefore of poor overall quality. People cannot get the treatment and hospital care for their money that they would like. They have to find ways of adapting to a system in which they end up through no choice of their own.

Army reforms

The third example of this kind of nomenklatura privatisation comes not from the social sector but from the failure to complete reforms to the military. Russia's army has only been partially professionalised. Some units are manned by contract servicemen, ie servicemen who have signed contracts to serve in the Armed Forces and receive their wages accordingly. But the practice of compulsory military service remains in place.

True, military service has been cut from two years to one. This may have reduced the hazing that goes on among conscripts. For typically it was the conscripts serving their second year who would subject the new recruits to bullying and violence. But this has made young people no keener to serve in the Armed Forces. Not only do they fear the bullying there. They also do not want to lose a year better spent on studying and getting their careers underway. This leads to a widespread practice of bribing the officers responsible for the annual intake of new conscripts in the local military commissions to defer service. Alternatively, doctors are bribed to issue a certificate declaring them unfit for military service on medical grounds. Thus it is not only the army that has an interest in putting the brake on military reform. Essentially, the system has created a vast market for bribes that enable many officers and doctors to profit from their positions.

It is interesting to note that those who take bribes swiftly adapt to any change in the status quo, and find ways to turn it to their personal advantage. For example, the mere rumour that the authorities were contemplating a return to two-year military service provided profitable opportunities. Some young men, afraid that they would end up having to serve two years rather than one, were ready to pay bribes to get a deferral, while others wanted to ensure their conscription right now, while the one-year system was still definitely in place. Naturally the officers organising conscription were only too happy to take advantage of this situation, although the rumours in question proved groundless.

Pension reform

The failure to carry out much-needed reforms has resulted in another set of problems which are not yet being felt, but which will arise with time. These are problems which, if they were addressed now, would be possible to prevent.

The first example is pension reform. Russian pensioners receive very small state pensions today, and there are prospects for substantially changing this situation. Pension increases depend largely on the Russian state's wealth, which in turn depends on the inflow of petrodollars. But it also depends on the authorities' willingness to spend money on pensioners rather than on defence or law enforcement. Under the existing pension mechanism, the best the Russian state will be able to deliver is the indexation of pensions to keep up with inflation.

A model for reform has been drawn up to ensure that people coming to the end of their working lives in the future would not meet the same sorry fate as today's old-age pensioners. This model gives Russians a chance of saving money and putting it into a fund that will provide them with a decent future pension. The system's significance lay in the fact that people were not forced to make extra payments from their own incomes to save for their pensions. Part of the money currently paid into the state pension system would go into citizens' personal pension savings accounts instead of being used to pay pensions to the current generation of pensioners.

But this apparantly reasonable scheme contained a ‘bomb' capable of blowing the whole scheme apart. The state had somehow to compensate today's pensioners for the loss of the money that would otherwise go into citizens' personal pension accounts. It therefore had to look for other sources of revenue to make up the shortfall. This is always a hard task. The result is that everyone born before 1967 has been excluded from taking part in the new scheme In practice this means that people coming to the end of their working lives over the next 20 years will share the fate of today's pensioners. That is to say they will be poor and completely dependent on the state's unstable revenues.

Oil and gas

One last example of an area where the absence of reform will have a negative impact on the Russian economy in the future is the oil and gas industry.

Instead of continuing to privatise and de-monopolise the sector, the Russian authorities have been re-nationalising the industry recently. They have entirely abandoned any serious attempt at breaking up Gazprom. As for the oil industry, a large part of the assets formerly controlled by Mikhail Khodorkovsky's Yukos have gone to the state company Rosneft, while Sibneft, which was owned by Roman Abramovich, was acquired by the state-owned Gazprom.

The experience of this last decade has shown that in Russia private companies are better managed than state-owned ones. Management in private companies is closer to Western standards and there is a lot less stealing. Private companies spend less money on non-core business activities and focus more on ensuring future profits. State-owned companies like Gazprom and Rosneft pay little attention to developing new oil and gas fields. This is not surprising. The officials who run them have little incentive to think about the business's future in 15-20 years time, because the business does not belong to them.

Thus, the outlook for Russia's oil and gas industry looks rather bleak. If things don't change soon, the goose that lays the golden eggs on which the Russian budget depends will lose its marvellous power.

 

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